Europe should embrace failure

FRIDAY MACRO MIXER - MIXED SIGNALS PERSIST

The issues with employment, housing and policy-induced stock market volatility continue to weigh on economic growth and our overall prosperity. Consumer confidence also is a problem, as current levels of confidence indices are more supportive of a recessionary environment than of recovery. Retail sales figures released today certainly imply a healthier consumer in September than the confidence numbers do. If more credence is lent to the sentiment picture, it would seem appropriate to assume that a slowing in spending from here is likely, which would support our bearish view on the economy. If expectations are what drives consumer spending, the negative trends in consumer expectations do not bode well.

Today, the preliminary University of Michigan consumer sentiment index declined 1.9 points, with consumer expectations leading the way day (although both components declined). The index came in at 57.5, compared with September’s 59.4.

As we have said repeatedly, the economic drivers of confidence remain very mixed, and we do not expect significant improvement any time soon. The most pressing concern is continued labor market weakness, specifically the large number of discouraged workers that remain out of the labor force. This is evident in the chart below, showing the labor force participation rate declining precipitously throughout recent years. This week, jobless claims came in this at 404K (backing out the revision to last week's data, claims moved higher by 3K).

Our Financials Team continues to point out that the spread between claims and the S&P remains as wide as it's ever been in the last three years. If claims move to the level implied by the S&P that would be roughly 475k. Our Financials Team’s model indicates that a 475k claims level would be consistent with 0% GDP growth.

On the positive side, debt levels have been reduced substantially over the past two years and there are small signs that credit is very gradually becoming more available. This, along with the help of the federal government, is helping the outlook for spending on the margin.

It appears from the data that consumer spending finished 3Q11 on a positive note. The Commerce Department reported that retail sales rose 1.1% in September, its largest monthly gain since February 2011. While autos provided a boost to the overall figure, there was strength across the board, as the increase beat the Bloomberg consensus by 0.4%. Non-auto retail sales rose 0.6%, a modest acceleration from August’s 0.5% (was revised up from 0.1% last month).

Despite the disappointing consumer confidence levels, retail sales data suggests that consumers are finding a way to finance consumption despite the weak job and income headwinds. If savings are being sacrificed and this is a significant reason behind the strong numbers this month that clearly doesn’t bode well for the continuation of the improving consumption picture that we saw last month. In the end, the data is prolonging an environment of uncertainty.

On the earnings front, it’s been mixed thus far. Two companies that we paid close attention to from a consumer standpoint were PEP and SWY. Pepsico reported a low quality quarter and left its full-year EPS guidance unchanged although its expected FX benefit was lowered from 2% to 1%. SWY reported better-than-expected Q3 results vs low expectations. Industry volumes are under pressure, however, and the outlook is cautious due to the secular headwinds facing the industry. Grocers have been pricing aggressively to protect margins in the face of high inflation.

All in all, expectations are mounting for a “bazooka” bailout from Europe which, if less substantial than the market is hoping for, could be a catalyst to the downside. Hope is not, after all, an investment process.

King Dollar- In the last three years, the U.S. dollar has been a key driver of asset prices globally. In the intermediate term, the dollar is set up to outperform other major currencies.

Correlation Crash - Correlations are heightening globally within asset classes, across asset classes, and among disparate economies. The derivative risk is that correlations also increase the possibility of an interconnected crash.

Eurocrat Bazooka - As the monetary union falters in Europe, the only way out appears to be a Keynesian solution. Global markets will be influenced heavily by talk and potential implementation of the Bazooka.

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Correlation Crash - Correlations are heightening globally within asset classes, across asset classes, and among disparate economies. The derivative risk is that correlations also increase the possibility of an interconnected crash.

King Dollar - In the last three years, the U.S. dollar has been a key driver of asset prices globally. In the intermediate term, the dollar is set up to outperform other major currencies.

Eurocrat Bazooka - As the monetary union falters in Europe, the only way out appears to be a Keynesian solution. Global markets will be influenced heavily by talk and potential implementation of the Bazooka.

Please contact if you have any questions.

Regards,

The Hedgeye Sales Team

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10/14/11 09:09 AM EDT

THE HBM: SAFM, GMCR, SBUX, SONC, DIN

THE HEDGEYE BREAKFAST MONITOR

MACRO NOTES

Consumer

Yesterday’s initial jobless claims number came in at 404k versus expectations of 405k and the prior week’s revised 405k. The jobs picture is far from improving and, while the numbers are not deteriorating, we believe that casual dining needs an improvement in the jobs picture to boost demand.

Gasoline prices have ticked up over the last week as the dollar has weakened and some optimism on the economy has surfaced.

Advance Retail Sales for September came in at +1.1% versus expectations of 0.7%. Retail Sales Less Autos came in at 0.6% versus expectations of 0.3%.

China

China’s inflation came in at 6.1% in September, exceeding 6% for a fourth month in succession.

SUBSECTOR PERFORMANCE

FOOD PROCESSORS

SAFM: Sanderson Farms target increased to $52 from $48 at Stephens

QUICK SERVICE

GMCR: Green Mountain Coffee Roasters was upgraded by Longbow Research to Buy, with a price target of $112.

SBUX: Starbucks was reiterated “Overweight”at Piper Jaffray and its price target was raised to $55 from $50.

SONC: Sonic announced that its Board of Directors authorized a stock repurchase program for up to $30 million worth of common stock through August 31, 2012.

CASUAL DINING

DIN:DineEquity has announced that franchisee Neighborhood Restaurant Parnters purchased Apple Restaurants, which includes 40 Applebee’s in the Atlanta area. No terms of the agreement were disclosed.

According to the PBoC, September new loans were $470 BN yuan (US$73.7 BN), the least since 2009. Consumer prices rose 6.1% compared with a 4% goal. M2 money supply rose 13% YoY, the least in almost a decade, and data for foreign-exchange reserves pointed to capital outflows.

The Monetary Authority of Singapore (MAS) cut its 2012 GDP forecast from 5-6% to 5%. It also said it will reduce the slope of the policy band of its currency and continue with a modest and gradual appreciation. This is the 1st time of monetary policy easing since 2009. An advance estimate for S'pore 3Q GDP showed 1.3% QoQ growth and 5.9% YoY growth. MAS added that core inflation stood at 2.2% in the second quarter and the first two months of 3Q, compared to 1.9% in 1Q.

SWINE STREPTOCOCCUS CASE FOUND IN MACAU Macau Daily Times

A case of swine streptococcus was found in a 60-yr HK resident living in Macau.

MACAU PACKAGE TOURS AND HOTEL OCCUPANCY RATE FOR AUGUST 2011 DSEC

Visitor arrivals in package tours in August 2011 soared by 49.4% YoY to a record high of 713,383. Visitors from Mainland China (513,094); Taiwan (53,358); Hong Kong (33,356) and the Republic of Korea (30,532) surged by 46.6%, 124.2%, 28.8% and 113.6% respectively.

At the end of August 2011, total number of available guest rooms of hotels and guest-houses increased by 2,384 (+12.1% YoY) to 22,151 rooms, with that of 5-star hotels accounting for 63.4% of the total. Hotels and guest-houses received 809,120 guests in August 2011, up by 16.3% YoY, with the majority coming from Mainland China (53.9% of total) and Hong Kong (21.8%). The average length of stay of guests decreased by 0.05 night to 1.4 nights.

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